Being Realistic About Equity

My client was concerned. After five years of systematically investing in equity funds his IRR or annualized return was a mere 7%. He isn't sure if investments in equity mutual funds are right for him anymore. Many investors started off with SIPs in equity under the notion that they are entitled to a 20-25% return on a compounded basis and anything below this is too poor. Despite years of market experience behind us , investors seem to have very unreal expectations from equity investments . Unfortunately many also tend to shy away from equity investments when  such expectations are not met . Equities are the best long term assets to invest in provided you are clear about the time frame of investments, expected returns , portfolio quality and lastly whether your financial situation allows for such long term investments. Being Realistic about the Time frame - Every analyst or fund manager would tell us that we need to give a minimum 3 to 5 years while investing in equities. Five years is a reasonably long period, but in the equity world it is the shortest possible time frame. Indeed as financial planners we always allocate higher equity investments to goals that are the furthest away in time, possibly 10 to 15 years away. One could trade for short term gains, but that is speculation, not investment, and beyond my scope of advise . Being Realistic about returns - When risk free bonds (10 year G SECS) offer  8% return, equities should offer returns in excess of this by a number called risk premium. In India historically this premium is in the range of 6%to 7%. This in turn means reasonable range of expected returns in equities is between 12 %to 15%. Yes there are years in which you could see a 25% return, but this is abnormal and the return will eventually revert to the mean return range of 12% to 15%. Realistic assessment of the quality of your portfolio - If you are stuck with a bad fund manager, or a poor quality portfolio it is unlikely that even a 12 to 15% return will be achieved. Lets say you have an infrastructure portfolio consisting of real estate and highly leveraged infrastructure stocks that have lost 3/4th of their value since 2007. Even waiting for another ten years may not bring your capital back to par. Hence it turns out that you do need a good fund manager or good stock picking skills to achieve reasonable returns in equities. Being realistic about your financial situation - Lastly equities have to be part of a plan. If you have a huge outstanding loan, or have irregular income flows or an unstable job, you must have a lower allocation to equities. You are more likely to be ruffled by lower returns if all you have invested is in equities and very little in anything else. Having an allocation to debt brings stability to your portfolio and allows you to invest when valuations are attractive. If you don't have debt, then start accumulating some. Allocate equities only to longer financial goals like retirement and wealth building and remember to re-balance periodically. My client needs to continue investing in equities via SIPs. He must however review his MF portfolio and get rid of some of the thematic funds he had invested in. If he continues investing systematically in diversified well managed funds he is more likely to achieve his financial goals.